Text of June 3, 1992 opening address at Fed/Treasury
"Forum on Changes"

Robert J. Weber

Thank you, Mr. Secretary. Good morning, ladies and gentlemen.

Auctions have been in use for more than two thousand years. The
Babylonians arranged marriages by auction. The Roman legions sold
plundered booty at auction. Today, tobacco, fish, cut flowers,
works of art, thoroughbred horses, and used cars are sold at auction.
Developers auction homes. Contracts are let by competitive bid.
The federal government sells natural resources at auction. Pollution
rights, and the radio airwaves, are soon to be up for bid. And,
in the largest auctions in the history of mankind, the U.S. Treasury
sells debt. It is this last auction market which we are here to
discuss today.

My goal this morning is to set a general stage for the more specific
discussions to follow. So let me begin by talking about the various
types of auctions that are in common use. I'll begin with a discussion
of single-item auctions, and later generalize what we know to
the sale of multiple units, such as Treasury securities.

The oldest of auction procedures is the ascending-bid auction,
in which bidders indicate a willingness to pay higher and higher
prices, until only one remains. Such auctions predate the Roman
Empire. Indeed, the Latin phrase caveat emptor, often mistranslated
as "let the buyer beware," more literally means "let
the highest bidder beware: All sales are final."

The ascending-bid auction solves a simple problem: It establishes
a market-clearing price, in cases where the seller lacks the information
needed to set that price directly. For when only one bidder remains,
it can be assumed that the bidding has reached a level where only
one unit of demand remains, matching the single unit of supply.

There are, of course, many prices at which the market might clear,
ranging from the maximum amount that the second-highest bidder
was willing to pay, on up to the maximum that the winner would
have agreed to pay. The ascending-bid auction guarantees the seller
no more than the lowest price in this range; the seller's inability
to extract more revenue from the sale is the price he must pay
for his lack of prior information about the true shape of the
demand curve.

The standard sealed-bid auction, in which the submitter of the
highest bid is declared the winner and pays the amount of his
bid, evolved quite naturally from the ascending-bid auction. Bidders,
knowing of a sale but unable to attend in person, would transmit
a bid to the auctioneer in advance of the auction. The auctioneer
would then enter this bid on the submitter's behalf. If no "active,
present" bidder was willing to top that bid, the absentee
bidder would be declared the winner, and would (quite naturally)
be charged the amount of his submitted bid.

But was this really the "natural" way for the absentee
bidder to be represented? The bidder would, of course, have preferred
to submit instructions of the form, "Keep me in the auction
at minimum price increments, until my submitted limit is passed,
or until the bidding stops." But the auctioneer was typically
either the seller himself, or an agent of the seller. The auctioneer's
incentive was to obtain the highest possible price. And the absentee
bidder, unable to monitor the bidding directly, was forced to
accept the auctioneer's word about when the competition had finally
dropped out. The cleanest resolution to this incentive problem
was simply to agree that the submitted bid would be entered directly
into the bidding at the specified level; then, at least, no charge
of auctioneer dishonesty need ever be made.

This understanding forced an absentee bidder to think somewhat
strategically. One profits from a transaction by buying at a price
below one's actual valuation of the object being sold. Bidding
in person provided a profit, as long as the bidding of others
ceased somewhere below the valuation of the eventual winner: The
appropriate strategy for any present bidder was to remain active
until the bidding of others ceased, or his own valuation was passed.
But an absentee bidder could only hope to profit by submitting
a bid strictly below his true valuation.

And, once absentee bidding was allowed, the existence of even
a single absentee bid raised the specter of sale taking place
at a non-market-clearing price. If the item at auction was sold
to an active bidder at a price only slightly above a submitted
bid, there remained the chance that the absentee bidder truly
valued the item at auction at more than the final price. Thus
was born the notion of "loser's regret", a notion not
relevant to pure ascending-bid auctions: A bidder could learn
that he had lost to a bid which he would, if present, have been
willing to top. Another way of looking at this is that, even if
all of the bidders bid rationally, the price determined by a traditional
sealed-bid auction is not necessarily a market-clearing price:
There might be residual demand at that price.

Of course, "winner's regret" was also a new phenomenon,
as the submitter of a winning bid always faced the possibility
that a lower bid would still have won for him, and would have
yielded a lower price.

Still, the submission of sealed bids became common, to the point
that, for some types of sales, the ascending-bid phase of the
auction was abandoned completely. The growing efficiency of communications
infrastructures made it possible for the specifics of a sale to
be widely distributed, and for the submission of bids via postal
or electronic communications to be inexpensive and reliable.

But these sealed-bid auctions - called "first-price"
auctions, since the highest of all bids established the price
- were economic aberrations, arising from an inability on the
part of bidders to trust that the seller would carry out more
detailed instructions. The economic rationale of these procedures
was incomplete, since they did not always establish market-clearing
prices. Yet the discriminatory-price auctions currently used to
sell Treasury securities are based directly on the general notion
of charging each winning bidder the amount of his bid.

Not until the late 1950's did the proper sealed-bid analog of
an ascending-bid auction come under discussion. This alternative
procedure is known as a second-price auction. The submitter of
the highest bid is awarded the item being sold, but is charged
only a price equal to the second-highest of the submitted bids.
This second-price procedure accurately emulates an ascending bid
auction, in which the instructions of absentee bidders are to
keep them in the auction at minimum bid increments until the bidding
stops or their submission level is reached.

A naive reaction to a proposal to replace a first-price auction
with a second-price auction would be to expect that the seller
would reap smaller revenues. But of course bidders could be expected
to bid somewhat more aggressively, if they knew that the winner's
payment would be only the amount of the second-highest bid, so
revenue implications actually are not immediately obvious. In
order to discuss the impact of auction rules on the seller's revenues
(and consequently, on the bidders' potential profits from participation,
since the two are inversely related), it is necessary to specify
an economic context in which the auction takes place. Two extreme
contexts, at opposite ends of the economic spectrum, have received
substantial attention.

One is the independent private-values context, in which each bidder
knows his personal valuation of the object being sold, and these
valuations differ from bidder to bidder. The independent private-values
context is descriptive of the market for a pure consumption good,
or of a market involving bidders who are acting as agents for
their customers, with predetermined prices waiting for them should
they happen to win the auction.

Of course, this context is not completely descriptive of the sale
of Treasury securities, a sale which involves bidders acting both
as agents for their customers and in their own behalves, with
an active secondary market following the sale. But what we know
about auctions in the private-values setting can provide a benchmark
for discussion of the more relevant "common-value" context
which I'll talk about in a few minutes.

In the independent private-values setting, an analysis of the
strategic elements of a sealed-bid second-price auction is trivial:
With no further assumptions concerning differences between the
bidders in valuations, or differences in their attitudes towards
risk, or even concerning the level of sophistication of one's
competitors, we find that one strategy is dominant: Bid precisely
your own private valuation. If all of the others bid less than
you, you win and turn a profit. A lower bid would not have yielded
any more profit, since the price you pay if you win is unaffected
by a reduction in your own bid. The reduction would only expose
you to some chance of losing the auction, and making nothing.
Similarly, the only change which could result from bidding more
than your own valuation is that you pass a higher bid, and win.
But the price you will face will be equal to the bid you passed,
and hence you'll lose money. Bidding your own value is the only
sensible action.

And what of the seller's revenue? If all bidders act sensibly,
the seller will collect an amount equal to the second-highest
of all outstanding valuations, which, as noted before in our discussion
of the ascending-bid auction, is the lowest price at which the
market clears.

A strategic analysis of sealed-bid first-price auctions is somewhat
more complicated, and is dependent on assumptions concerning the
distribution of private valuations among the bidders, and about
their level of aversion to risk. It would not be useful to go
into details in this forum, other than to note that, obviously,
bidders should bid at a discount from their true valuations. But
one striking fact results from the detailed analysis: If the private
valuations are independent draws from a fixed distribution of
"tastes", and the bidders are all risk-neutral over
the range of relevant payoffs, then, on average, the seller's
revenues will be precisely the same as from a second-price auction:
The winning bid will, on average, just equal the second-highest
of all valuations! This result, first noted by Professor Vickrey
in the late 50's, has come to be known to economists as the
"Revenue Equivalence Theorem." (Note that this is an
"on-average" result. It does not assert that auction
outcomes will be the same under both sets of rules. It only says
that the seller, prior to the auction, has no reason to expect
either type of procedure to generate higher revenues than the
other.)

About 15 years ago, the Revenue Equivalence Theorem was extended
to cover all other methods by which a sale might be organized.
One might imagine other types of rules. The high bidder might
be charged the average of all of the submitted bids. Or all bidders
might simply send money to the seller, with the sender of the
highest amount obtaining the object being auctioned, and the seller
keeping all of the submitted amounts. (One might cynically view
this as a model of "legislative lobbying".)

But, as long as the bidders know their own valuations, are risk-neutral,
act rationally, and the sale eventually goes to the bidder who
values the object most highly, the seller always will obtain,
on average, an amount equal to the second-highest valuation.

A natural question, then, is whether the seller should care which
procedure is used. And the answer is YES, a seller SHOULD care.
This theoretical result should be viewed only as a benchmark,
against which variations can be compared. Consider three variations
in the assumptions:

First, the revenue-equivalence result assumes sensible, rational
competitive behavior from the bidders. This assumption breaks
down somewhat more frequently in first-price auctions, where detailed
strategic considerations are quite complex, than in second-price
auctions. The breakdown can yield differences in revenues.

The result also assumes risk-neutral bidders. It is not difficult
to see that, when bidders are risk-averse, the first-price auction
will extract higher revenues than the second-price auction. In
a first-price auction, the "loser's regret" phenomenon
- the possibility of losing the auction, when a somewhat higher
bid might have profitably won - will lead to higher bids from
risk-averse bidders, while in the second-price auction, the "bid-your-own-valuation"
strategy remains dominant. So, in the presence of risk aversion,
the seller benefits from the first-price procedure.

And finally, the revenue equivalence result only bounds the seller's
revenues if the object being auctioned is guaranteed to be sold.
But, just as in negotiations, sellers can benefit from threatening
to not close the deal. For example, by setting a reserve price
(that is, a bid of his own), a seller threatens to not sell if
bids are too low. And it can be shown that there is always some
reserve price which will, on average, increase the seller's revenues
over those obtained from the use of the same auction rule, without
a reserve price. (Indeed, while making more money per sale, the
seller also gets to sometimes retain the item being sold!)

Still, these three variations are of little relevance to us today.
The magnitude of the issues of Treasury securities makes it likely
that participants will not regularly engage in unsophisticated
bidding behavior. At the same time, the financial size of most
participants and the frequency of sales means that risk aversion
will not be a major factor in any single auction. And finally,
current fiscal policy requires the complete placement of every
issue, so the use of a reserve price is not considered a viable
option.

But a fourth violation of our assumptions, which again leads to
invalidation of the revenue-equivalence result, is real, and of
extreme importance. This is the fact that Treasury securities
are not privately valued - that Treasuries are durable goods,
for which there exists an active secondary market. Uncertainties
about future prices in that market create uncertainties for each
bidder, at the time of the auction, about the true value of the
securities being sold.

So let's consider an economic setting polar to the independent
private-values context. Consider the common-value context, in
which the item being sold has the same value to all bidders, yet
no bidder knows that value for certain. Instead, each bidder holds
a private estimate of what that value is. A new, striking
phenomenon arises in this common-values setting - a phenomenon
known as the "Winner's Curse."

The common-value setting is roughly descriptive of the federal
government's leasing at auction of petroleum extraction rights
on a tract of land: There's a fixed amount of oil there, but no-one
knows how much, or what the extraction costs will be, or what
the market price of crude will be at the time of extraction. Yet
all of these economic factors are approximately equal for all
bidders, each of whom holds a private estimate of the value of
the lease based on their own geological estimates and economic
forecasts. If the estimation processes are unbiased, then it is
likely that some of the estimates are too high, and others too
low. Now, imagine that your firm, facing a first-price auction,
has submitted a sealed bid of $50 million for a tract that you
estimate to be worth $60 million. And the telephone rings, and
you're informed that you've won the auction. As you set down the
phone, what goes through your mind? Well, you've just learned
something that you didn't know before: That every competitor bid
less than you. If $50 million was truly the appropriate strategic
bid for a firm holding a private estimate of $60 million for the
value of the tract, then you can now infer that the other competing
firms all held estimates somewhat less than yours: The estimate
of $60 million was an extreme outlier. Assuming the other firms
to be as good as yours at making estimates, this new news is bad
news, and forces you to downgrade your original estimate.

Now, the Winner's Curse should not be misinterpreted. It certainly
does not imply that the winning bidder will lose money.
If, in the example just given, the "bad" news that every
other competitor held a lower estimate than you leads you to lower
your original estimate from $60 million to $55 million, you still
are happy to have won the auction, for you still have an expected
profit of $5 million. Exposure to the Winner's Curse simply forces
bidders to scale back their bids somewhat, to protect themselves
in case they do, in fact, win the auction.

And thus, in a rational market, the Winner's Curse does not truly
curse the bidders: It curses the seller! For this scaling back
of bids reduces the expected price obtained by the seller from
the auction.

How can a seller fight the revenue-reduction caused by the bidders'
reaction to the Winner's Curse? The natural approach - the only
approach - is to reduce the exposure of the bidders to the Winner's
Curse. For example, if the seller knew the true value of the object
being sold, and could convincingly reveal that information to
all of the bidders, one could expect competition to push the price
up to that true value, maximizing the seller's revenues in the
process of clearing the market at the unique market-clearing price.

Of course, in the sale of mineral extraction rights, or for that
matter in the sale of Treasury securities, the seller - the government
- does not have perfect information. Still, some information
is held by the government at the time of sale. And it has been
shown (in theory), and should be expected to be true in practice,
that a policy of full and accurate public revelation of all knowledge
held by the seller is the policy which maximizes revenues.

Note that I used the word "policy" in the last statement.
Of course, suppressing bad news, or even distorting it into good
news, can be advantageous to a seller in the short run. A major
art auction house, holding incontrovertible evidence that a particular
work is a forgery, could tell bidders that it believed the work
to be genuine. It would make more money from the sale of that
work. But its reputation - if not for honesty, then at least for
the ability to make accurate appraisals - would be damaged, leading
to lower revenues from future auctions. We have here one of the
few instances in which economic theory justifies a well-known
adage, namely, that "Honesty is the best policy."

Honest announcement of appraisals is one approach that a seller
can take in reducing the exposure of individual bidders to the
Winner's Curse. Another approach is to let the market generate
relevant public information on its own, prior to the moment of
sale. Again referring to the leasing of mineral rights, note that
the holders of rights on tracts of land already leased must file
extraction reports with the government, and some of the information
contained in these reports becomes a matter of public record.
This information is of value to all of the bidders involved in
subsequent auctions of leases on nearby tracts.

The when-issued market plays much the same role prior to the sale
at auction of Treasury securities. It provides a publicly-available
composite view of market participants concerning the true eventual
value of the securities to be auctioned. In doing so, it reduces
the exposure of individual bidders to the Winner's Curse, and
consequently elicits somewhat higher bids, on average, at auction
than would be obtained if when-issued trading were not allowed.

There is yet another approach a seller can take, in fighting the
revenue-reducing effects of the Winner's Curse. That is to use
an auction procedure which lets the price paid by a winning bidder
depend on information other than just his own. In a second-price
auction, the winning bidder expects to pay a relatively high price
only if some other bidder holds an estimate nearly as high as
his own. If all other bidders hold significantly smaller estimates,
and make significantly smaller bids than he, the price he pays
will be low. This correlation between price and the estimate of
another bidder lessens the effect of the Winner's Curse on each
individual bidder, and therefore benefits the seller: In a common-value
setting, the Revenue-Equivalence result breaks down, and sellers
should prefer to use second-price auctions.

An ascending-bid auction cashes in on both of the previously-discussed
methods of reducing the exposure of the bidders to the Winner's
Curse. Information about the estimates of others, inferred from
the level of competition as the price climbs, has the same effect
as information revealed by the seller. Then the price finally
paid by the highest bidder is close to the point at which the
second-highest bidder chooses to drop out of the competition,
yielding an additional benefit similar to that gained from a second-price
auction. The combination of these two effects leads to the natural
conclusion: The seller's revenue from the use of an ascending-bid
auction will, on average, be greater than from the use of a second-price
auction, which in turn will be greater than from the use of a
first-price auction.

What of strategic issues? In a second-price or ascending-bid auction,
strategic issues remain relatively simple even in a common-values
setting. Take all of the publicly-available information into account,
and then ask yourself: "If I knew that my estimate was really
the highest, and that the second-highest estimate was just marginally
below mine, what would I then revise my estimate to be?"
Bid that amount! In game-theoretic language, the market will resolve
itself "in equilibrium" if all bidders follow this strategy.

Just as in the independent private-values setting, second-price
and ascending-bid auctions have the "no-regret" feature,
that even when the auction is over, no bidder will find himself
wishing that he'd bid differently. The assumption on which the
winner's bid is based, that the highest rejected bid is as high
as his own, is overly optimistic. The assumption on which the
price-determining, next-to-highest bid is based - that the winning
bid is no higher - is overly pessimistic. Therefore, the winning
bidder is always happy to have won at the price he must pay, while
the losing bidder would not, even after the fact, have wanted
to have entered a bid higher than the winner's. The auction will
always establish a market-clearing price, even in the common-value
setting.

In summary, this is the state of economic theory as it currently
stands, with respect to seller's revenues: If the aversion of
individual bidders to risk is a small factor, relative to the
existence of common uncertainty about the value of the item being
sold, and if the market is reasonably symmetric, in the sense
that no bidders hold substantial informational advantages over
the others, then sellers benefit from using second-price auctions
in place of first-price auctions, and benefit even more from the
use of ascending-bid auctions.

How do these results carry over to the sale of multiple units,
such as the auctioning of Treasury securities?

The discriminatory pricing procedure currently in use is, of course,
a direct extension of the first-price sealed-bid auction, in which
each winning bidder pays the amount of his bid.

The second-price auction naturally generalizes to a uniform-price
auction, where all bidders pay an equal price corresponding to
the highest rejected bid. (Note that this is not quite the same
as the proposed uniform-price auction, in which the lowest accepted
bid, rather than the highest rejected, determines the uniform
price. But with the large number of units available at Treasury
auctions, it doesn't hurt to view the two pricing rules as equivalent.)

And finally, the ascending-bid auction corresponds closely to
the procedure to be laid out in more detail by Dr. Reinhart in
this afternoon's session.

The revenue effects found in the single-item setting all carry
over directly to the multiple-unit setting: Ascending-bid and
uniform-price auctions should generate higher revenues - which
means, for the Treasury, lower financing costs - than the currently-used
discriminatory-price auctions.

Next, let's consider the incentives of individual bidders to obtain
informational advantages over their competitors. How might a change
in procedures affect current participants, and the structure of
the pre-auction and post-auction markets?

Consider the value of private information. For first-price and
discriminatory-price auctions, the situation is simple: Without
private information, or an advantage in terms of attitude towards
risk, one can't expect to make any money. In fact, in the presence
of several bidders, each strictly better-informed than you, stay
out of the auction. The Winner's Curse lashes out at uninformed
bidders with a vengeance.

This provides substantial incentive for some bidders to stake
out positions providing themselves with extreme informational
advantages. One shouldn't be surprised to find a structure very
similar to that in the current market for U.S. Treasury securities.
A modest number of firms (such as a number of the primary dealers)
make a substantial investment in information-gathering technology.
Once they achieve an informational advantage, it makes little
sense for less-well-informed firms to attempt to participate directly
in the auctions. And at the same time, the marginal returns to
becoming as well-informed as those who came before become smaller
and smaller, until finally no new firms can justify putting information-collection
departments of their own in place. Instead, they either participate
only indirectly, as customers of the primary dealers, or they
do most of their trading on the secondary market. Competition
in the auction thins out, which benefits the remaining bidders
at the expense of the seller. Thinner competition in the auction
market also provides additional opportunities to those still in
to take manipulative actions.

In this regard, note that many institutions, finding themselves
at an informational disadvantage, currently enter non-competitive
bids for the maximum allowed quantity. Indeed, the Treasury has
at times been forced to actions specifically designed to stop
employees of firms from bidding noncompetitively on their employer's
behalf, and to stop bank holding companies from having every branch
submit a separate, maximum-quantity noncompetitive bid.

In a uniform-price auction, private information is still of value.
But the value is lessened. Private information allows a firm to
correlate the times it wins with the times that favorable prices
result, but most of the correlation between the amount bid and
the price paid disappears. Informationally-disadvantaged firms
find it much more attractive to participate, because the price
they will pay, if they win, is a price which incorporates much
of the information held by their better-informed counterparts.

So, uniform-price auctions have two beneficial effects. They encourage
more competition, which benefits the seller directly. At the same
time, they lessen the incentives for individual firms to seek
marked informational advantages on a continuing basis.

Of course, part of the impetus for today's forum is the fallout
from Salomon's misadventures last year. How might a change in
the rules lessen the chances of similar problems in the future?

Well, how can one strategically generate extra profits
in the secondary market? As you are all aware, one of the simplest
ways to do this is by taking control of an issue, and generating
a short squeeze. Indeed, Salomon took precisely this approach
last year. They were punished. But what really was their mistake?
A cynical view is that they were simply wrong in trying to do
it all by themselves. For there was nothing that they tried that
could not have been done without falsified bids by three
bidders working in concert.

Should the Treasury be concerned with short squeezes? A naive,
short-term view is that an attempted squeeze generates extra revenues
for the Treasury, since the attempt requires outbidding most of
the other auction participants. But of course the concern is that
exposure to squeezes will increase risk in the market for Treasury
securities, and in the longer term will raise financing costs.

Here, note that the use of uniform-price auctions will make attempted
squeezes more costly. Second-price auctions yield greater bid
dispersion (and price variance) than do first-price auctions.
That greater dispersion in bids carries over to uniform-price
auctions, making it more costly to outbid other competitors. Indeed,
this dispersion will be increased even more by the fact that there
will be no practical limit on noncompetitive bids. For, in a uniform-price
auction, a noncompetitive bid is equivalent to a bid at an extremely
high price, and I can't conceive of any way to formally outlaw
such bids. Indeed, I suspect that, under a uniform-pricing arrangement,
the submission of multi-price bid schedules will become more common,
and the dispersion in individual schedules will increase, as bidders
take advantage of the opportunity to guarantee that a part
of their demand will be filled, by bidding very aggressively for
that part.

It is worth noting here that the current system, as well as any
revisions that are implemented, should be supplemented with guidelines
concerning the appropriateness of different types of pre-auction
communication amongst intended bidders. Discussion of the likely
stop-price must be distinguished and separated from discussion
of precise bidding intentions. Issues concerning strategic manipulability
of various auction procedures will be discussed in further detail
by Professor Marshall this afternoon.

----------

Much of what I said earlier was targeted at a single important
point: The proposed changes in auction procedures will not increase
the cost of financing the national debt. But how much lower can
financing costs go? What additional revenues might the Treasury
hope to capture by a change in rules?

Professor Sundarasan will discuss relationships between Treasury
auctions and the when-issued and futures markets in some detail
this afternoon. But I want to make a few broad comments up front.

Studies based on data from the 70's and 80's have suggested that
auctioned securities sold on average at substantially lower
prices than did the same securities on the secondary market. Estimates
of losses to the Treasury of 4 or more basis points are the norm
emerging from those studies. On the other hand, a recent Fed analysis
of data from just the last two years suggests that the gap has
narrowed substantially, to what appears to be less than a single
basis point.

While a fraction of a basis point is still substantial when viewed
across more than a trillion dollars in annual sales, the reduction
in revenue loss at auction suggests that the market has evolved
substantially over the past twenty years. Consider that evolution,
and how it relates to the choice of a sales mechanism.

I've already noted that it is in the seller's best interest to
have as much public information as possible available to the bidders
prior to the time of an auction. Back when sales were less systematic,
and volumes substantially lower, it was probably appropriate to
provide an incentive for some individual competitors to gather
information. The use of a discriminatory-pricing procedure provided
that incentive, by offering extra profits to those who made the
market.

But today, the market is much more complete. An active when-issued
market, a complementary futures market, and greater predictability
concerning the Treasury's long-term borrowing needs all help to
lessen the need to encourage substantial investment in information-gathering
from any individual bidder. With that encouragement no longer
needed, it becomes appropriate to switch to a procedure which
lessens the rewards which accrue to the informationally-advantaged.

As the Appendix to the January joint report indicates, several
other nations already place a portion of their debt through the
use of uniform-price auctions. In preparing for today's forum,
I was surprised to hear, albeit very informally, that some of
those nations are thinking of switching to discriminatory-price
auctions. But on further reflection, I was able to reconcile that
with the current push to move the U.S. towards the use of uniform-price
auctions. Our secondary and ancillary markets are more mature
- more complete - than those foreign markets. And therefore
it might well be that, while they perceive a need to offer extraordinary
compensation to central market participants, we have finally passed
the point where we should do so.

Much of my discussion this morning has focused on uniform-price
procedures, rather than on the further step to ascending-bid auctions.
One reason for my emphasis is that the precise proposals concerning
that second step will not be on the table until later today.

But another reason is that, from my personal point of view, the
most important step is the first one, to uniform-price procedures.
I can see no revenue-related issue, no market-related issue, no
strategic issue which fails to favor this first step, and I consider
it possible that the first step will rationalize the current market
and address its problems sufficiently well to make the further
step to ascending-bid auctions unnecessary.

Certainly, I can see no reason to wait until electronic bid submission
is in place before beginning the uniform-price experiments. I
am confident that the experiments will be deemed a success - after
all, it appears that the series of experiments in the early 1970's
were already successful, and were ended for political, rather
than economic reasons. Indeed, I am so confident in the eventual
success of the experiments that I hope they will be structured
in a manner designed not only to collect data, but also to begin
the evolutionary process of fully replacing discriminatory-price
auctions. I would personally support a phased schedule which moves
several issues over to uniform pricing on a long-term commitment
basis, at several different points along the yield curve, e.g.
the 26-week bill, and the two- and seven-year notes. And I would
like to see a schedule which holds open the possibility of adding
further issues to the uniform-price list as favorable evidence
comes in, rather than seeing an experiment which moves individual
issues back and forth between methods. Professor Chari will discuss
the issue of the scheduling of experiments in more detail this
afternoon.

My segment of this morning's program is nearly over. So let me
give one final summary of what economic theory has to say: In
settings with a fixed pool of bidders, uniform-price and ascending-bid
auctions yield greater revenue for the seller than do discriminatory-price
auctions. With respect to Treasury securities in particular, this
translates to a lesser burden on the taxpayer to finance the national
debt. Beyond this, uniform-price and ascending-bid auctions should
generate a larger pool of active bidders by eliminating both winner's
and loser's regret, and by reducing the risk of participation
for bidders at an informational disadvantage. This should consequently
reduce the overall cost to the economy of information-collection
activities, by reducing the competitive advantages gained by a
bidder from becoming appreciably better-informed than his competitors.
And finally, by eliciting more competition, increasing the dispersion
of bids, and permitting individual bidders to guarantee that a
portion of their demand will be filled, uniform-price and ascending-bid
auctions will make market manipulation much more difficult.

First-price auctions, and their discriminatory-price analogues,
are economic aberrations which have their roots in a distrust
in sellers. Second-price and uniform-price auctions are already
beginning to supplant them in many circles. The Italian government
has placed construction contracts using second-price auctions.
There are individuals in today's audience who are actively involved
in arranging second-price auctions for major corporate clients.
The Argentine government placed better than a billion shares in
the national telephone system into private hands this past winter
using a uniform-price auction.

It seems to me that the time is right to move the largest auction
market of all onto a more rational economic foundation.

In 1959, Milton Friedman stood before a Congressional committee
and recommended that Treasury securities be sold through the use
of uniform-price auctions. He continued to press his recommendation
on a number of subsequent occasions. Perhaps, as I mentioned earlier,
the market had not yet evolved to the point where the transition
was justified. Perhaps he was somewhat ahead of his time. But
the right time has now arrived.

A couple of weeks ago, I spoke with Professor Friedman concerning
this meeting. He wished us all luck, but also predicted that,
once again, the political process would ultimately subvert any
attempt to bring about the recommended changes. I'd like to see
him proven wrong, and I guarantee you all that he, as well, would
be happy to be wrong this time. A third of a century is long enough
to wait. The market has matured to the point where the recommended
changes are practical. The climate is right to restore confidence
in the non-manipulability of an extraordinarily important market.
The time to act is now!